João Soares: Battle of the Banks in Europe

The difference between healthy and weak European banks lies in the strength of their balance sheets and their profitability and efficiency. João Soares, a partner with Bain's Financial Services practice, outlines a proven formula that can help any bank become a winner in three to five years.

JOÃO SOARES: We've been working with a number of banks over the last few years in Europe, and we've been helping them rethink their business models. This led us to actually figure out, in terms of framework, that a number of banks are winning the battle and a number of banks are falling behind. And so the way we think about this is that there is an element of profitability and efficiency, which basically measures the bank's ability to generate capital organically every year. And there's also the oil tanker view on the banks, which is the balance sheet.

So, what's your position in terms of quality of loans—asset quality? What's your position in terms of liquidity? And what's your position on capital?

And so, combining these two dimensions, profitability and efficiency, and the balance sheet, what you get is a two-by-two matrix. And so you have the winners that are outperforming on all dimensions. You have the highest concern with [banks that are] underperforming on all dimensions, and sometimes for a few years.

And then you have the banks that have either a good business model and they are able to generate profits, but their balance sheet is troubled. Or you have—on the other dimension or on the other part of the axis—the banks that have a robust balance sheet. They've been recapitalized, but they're struggling to find what their business model is and what is their ability to generate capital organically.

And so, with these two dimensions, what we've found also is that the gap in value is huge. So if you're a winner, you're actually four times more valuable than if you're a laggard. And so when we discuss with regulators, with management teams and with investors, this gap in value is one of their key elements of concern and/or intention. And so if you're a laggard, if you're a highest-concern bank, you can become a winner in a period of three to five years, or even shorter.

And what do you do to become a winner? And we've worked with banks now and this is a proven formula that has worked throughout different countries. What you do is that you first address your balance sheet. And so you resize your balance sheet by getting rid of nonperforming assets and by shedding noncore assets. And then adjust your funding mix by shedding wholesale funding and going more into the deposit base.

You cut your cost base by, not blindly, but by doing a zero-based redesign in which you figure out what do you actually need to serve the new profit pools. And lastly, but more relevantly, what is your new business model? What is your digital approach to serving customers? And there are banks that have now been experimenting and succeeding with this digital business model for the past five years, going into digital relationship management, rethinking their operations. And so they've jumped from the weakest position on the matrix to becoming clear winners.

And so this path, this journey, can be achieved, increases your value by four times, and there are now proven cases throughout Europe of doing it.